The New Zealand Commerce Commission today released its final determination on one aspect of its approach to estimating the Weighted Average Cost of Capital (WACC) for regulated electricity lines and gas pipeline businesses in New Zealand.  When determining regulated prices for these businesses, the Commission needs to determine an appropriate return on capital.  Prior to this decision, the Commission did so by estimating a WACC range and applying the rate that corresponded to the 75^th percentile of that range.

Following a recent judicial appeal, several consumer groups asked the Commission to urgently review its methodology.  The Major Electricity Users’ Group argued that the Commission should apply the midpoint of its estimated range rather than the 75^th percentile.  In response to this request, the Commission commenced a nine-month review of its approach to this specific aspect of its WACC methodology.

The Commission concluded that:

• a regulated business’s true WACC cannot be observed – it must be estimated, usually with imprecision
• allowing a business too low a return on capital (i.e. relative to its true required return) may result in under-investment and a reduction in service quality
• the harm to consumers from under-investment likely outweighs the harm to consumers from over-estimating WACC and
• going forward, it would apply the 67^th percentile of the WACC range rather than the 75^th percentile.

The Commission took account of a wide range of evidence submitted by stakeholders, including modelling and analysis undertaken by Frontier (Australia), on behalf of Transpower New Zealand Ltd.  Frontier’s work examined the impact on consumer and overall societal welfare associated with applying different WACC percentiles when setting regulated prices.

Frontier regularly advises clients on cost of capital and network regulation issues. For more information, please contact m.okeeffe@frontier-economics.com.au or phone +61 3 9620 4488.

Frontier Economics (Australia) Chairman Philip Williams presented at the 12^th Annual University of South Australia Competition and Consumer Workshop, held 10-11 October 2014.

Philip presented a session on the proposed changes to Section 46 of the Competition and Consumer Act 2010, put forward in the Draft Report of the Competition Policy Review. This proposes that s 46 be re-framed to prohibit a corporation that has a substantial degree of power in a market from engaging in conduct if the proposed conduct has the purpose, or would have or be likely to have the effect, of substantially lessening competition in that or any other market.

However, it proposes that this primary prohibition should not apply if the conduct in question:

• would be a rational business decision or strategy by a corporation that did not have a substantial degree of power in the market; and
• would have the effect or likely effect of the conduct of benefiting the long-term interests of consumers.

Philip’s paper examines both the proposed primary prohibition and the defence in the light of the criteria adopted by the Review.

Frontier Economics regularly advises clients on a range of market power and other competition issues.

For more information, please contact Marita O’Keeffe on m.okeeffe@frontier-economics.com.au or phone +61 3 9620 4488.